The Real World vs. the Stock Market

September's Employment Situation was worse than expected Friday morning. Yet bad news is good news these days for those who think a second round of Fed quantitative easing (QE2) will bolster the markets. So stocks bolted into positive territory on the day, pushing up to Dow 11,000.

It’s an odd dichotomy. We have a somewhat improving economy. Yet the average person does not feel better about the situation. That’s because either they or someone close to them is out of work. (The classic economic joke is that a Recession is when your neighbor is out of work. A Depression is when you are.)

Along these lines I noticed something odd today. I drove to my children’s school for Parent-Teacher conferences. The school is 14 miles away along fairly busy roads. On the route are three McDonalds. That sounds fairly normal. But then I saw five Cash for Gold locations. Two of them are brand new; the other three came around just over the past couple years.

Yes, gold prices are high… but the real reason for the existence of these places is for people to trade in family heirlooms for cash because they are going broke. Then throw in all the vacant stores and it’s hard to get a sense that things are truly getting better.

So why are corporate profits going higher? Three main reasons:

1)Major cost cutting. Mostly on the staffing side of the equation. So each dollar in revenue produces more profit.

2)Modestly improving US economy moves up revenue a bit. Combine that with #1 above and it creates attractive year over year profit growth.

3)About half of US corporate profits these days come from overseas. Europe may be weak, but growth in China, India, Brazil etc. more than makes up for that shortfall.

This is why healthy corporate profits and a rising stock market seem to be disconnected from the realities in our own backyards. The good news is that conditions in the US should keep modestly improving, which certainly bolsters the case for the stock market going forward. Combine this with the alternatives to the stock market right now are not attractive.

Holding cash? No thanks.

Treasuries? That bubble is going to pop sometime (and yes I would recommend buying TBF or TBT for when that party takes place).

Gold? That is getting frothy right now. I might be tempted to pick up some on a pull back. But my history of trading gold is poor. In my long term account I’ve been riding the bull rally since 2002 when prices were around $300 per ounce. Still have plenty of shares on hand, mostly GDX (gold miners ETF).

There is lots in store next week when earnings season heats up. If good results combine with healthy guidance for the future, then the market will move to the recent highs of Dow 11,300. If the results are poor, then we'll probably see a retrace to the 50/200 day moving averages which are converged at around 10,500. My bet is that we do make it to 11,300. I'm not expecting much beyond that til next year.

My Two Cents

During the day I read many other investment articles of interest. Here are links to some new ones with my two cents added underneath.

There are a lot of estimate increases recently for the major rails. This is a very positive sign going into earnings season. I recently picked up some UNP because of it. But no shame in CSX Corp. (NYSE:CSX), Kansas City Southern (NYSE:KSU), Norfolk Southern (NYSE:NSC) etc.

All the fundamentals are going right for them including the recent drop in the US dollar making their exports more attractive. I personally prefer Cummins (NYSE:CMI) and Joy Global (JOYG). But no shame in owning CAT.

Agreed. No shortage of money. And no person in their right mind would hold cash right now if they felt there wasn't a better way to get a return. So if they are not risking that money it's because the reward isn't there. That is the problem.

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